Money Purchase Pension Plans – Fixed Profit Sharing Plans

How does a money purchase pension plan work?

A money purchase pension plan is a defined contribution plan that operates like a profit-sharing plan, and is typically replaced with a 401(k) profit sharing plan. The difference, however, is that profit sharing plans provide employers with the flexibility to adjust yearly contributions based on the profitability of the business, while money purchase pension plans require employers to make annual contributions of a fixed percentage – regardless of whether the business makes a profit. 

Is it like a 401(k)?

No. Only employers may contribute to a money purchase pension plan. Employees cannot make salary deferral contributions to the plan. But, like most 401(k) plans, employees may choose how to invest the money in their account among the options made available by the plan. Also, contributions are not taxable to employees until they are withdrawn, and investments grow tax deferred. Employers may attach a vesting schedule that requires employees to work a certain number of years before they are entitled to the funds in their plan account. Since employees can't make contributions to the plan, money purchase pension plans are often offered in combination with other types of retirement plans, such as a 401(k), which can significantly add to retirement savings.  

Money purchase pension plan contribution limit

Employers are required to make annual contributions of a fixed percentage of employee compensation. The percentage must be specified in the plan document. For 2020, an employee may receive up to 25% of their compensation or $57,000, whichever is less.

Can you roll a money purchase plan into an IRA?

As with other retirement plans, if an employee leaves the employer, they can roll their money purchase pension plan balance into a 401(k), 403(b), governmental 457(b) plan or IRA. Typically, upon retirement, employees may withdraw their plan assets in a lump sum or as periodic payments, which are taxed as ordinary income. Withdrawals prior to age 59½ are subject to the 10% early distribution tax (unless the individual meets an exception).  Money purchase pension plans are subject to the required minimum distribution (RMD) rules. 

Benefits of a money purchase pension plan

With a money purchase pension plan, employees enjoy a guaranteed retirement benefit, which makes it easy for employees to build their retirement savings. Providing such a benefit may also help employers recruit employees. Although employers are required to contribute to the plan, this can help with budgeting each year, and employers may take a deduction for their contributions to the plan. However, money purchase pension plans generally have higher administrative costs than other types of defined contribution retirement plans and they are less flexible for employers since the yearly contributions are fixed.

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